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The Standards Challenge

CPAs WHO IMPLEMENT ACCOUNTING
STANDARDS at corporations are responsible
for promoting the company’s accounting health and
ensuring that management understands the impact of
new regulations.

THE FIRST CHALLENGE FOR ANY
ACCOUNTING policy director is managing
the sheer volume of output the regulators produce.
The body of literature is ever growing, often
complex in its subject matter, increasingly
complicated by cross-references and historical
notes and highly specific.

IMPLEMENTING ACCOUNTING POLICY
at a financial institution requires the
leadership of a well-rounded finance professional
who understands both the business and the
accounting pronouncements. An important goal for a
CPA in this position is to assess what each
standard requires as early as possible and stay
ahead.

PARTICIPATION ON INDUSTRY
COMMITTEES and task forces gives
company representatives the opportunity not only
to share information and concerns but to unite in
an industry presentation to the regulators when
appropriate.

CPA INTERACTION WITH THE STANDARD
SETTERS can be an opportunity to voice
concerns and have an impact on a standard’s
outcome.

PAs who implement accounting standards at
corporations are responsible for promoting the company’s
accounting health and ensuring that management understands
the impact of new regulations. Implementing new accounting
standards can be difficult at even the smallest companies.
But a tough job just gets tougher at a global company with
many different operating segments. Regulators often look to
such an organization to help establish an industry position
on an accounting standard. Esther Mills, CPA, describes her
challenging job as director of accounting policy at Merrill
Lynch & Co.

The FASB Record

Since its creation in 1973, FASB has
issued 143 statements, not including special
reports and interpretations.

Source: FASB, Norwalk, Connecticut.

ORGANIZING A DUAL FUNCTION

Mills’ job consists of
two interrelated functions, internal and external, each
receiving about half her time and energies. The accounting
standard setters, FASB, the SEC, the AICPA and, at times,
other organizations such as the stock exchanges, drive both
components for Mills.

The first challenge for any
accounting policy director is managing the sheer volume of
output the regulators produce. The body of literature is
ever growing, often complex in its subject matter, highly
specific and increasingly complicated by cross-references
and historical notes. Sometimes policy directors even find
it can be a handicap to miss an important speech delivered
at a conference.

Implementing accounting policy at a
financial institution requires a well-rounded finance
professional who understands both the business and the
accounting pronouncements, no matter the size of the
company. An important goal for a CPA in this position is to
assess what each standard requires as early as possible and
stay ahead. One way Mills does that is by identifying who in
the sprawling company needs to give or get input.

Mills navigates the parallel aspects of her job with the
help of a staff of four accountants, all CPAs with 10 to 20
years of public and private experience. Some of Mills’ team
spends more time on internal consultation with the business
units, but she tries to make sure everyone participates to a
certain extent in external activities such as the industry
meetings.

There is also a three-person accounting
policy group in London which reports to both Mills and
Joseph Regan, the European controller. The chartered
accountants in London keep watch over a variety of Merrill
Lynch entities—including a major broker– dealer—that file
separate financial statements under UK GAAP. They also
review and provide accounting guidance on numerous complex
transactions originating in London and continental Europe
and respond to proposals of the UK Accounting Standards
Board.

The two accounting policy groups conduct an
employee exchange program in order to ensure cross-training
in the types of business in each location and the key
accounting issues that arise. Mills describes this program
as very successful in improving teamwork and communications.

The first step in a new project is brainstorming among
the accounting policy staff. Then the group reaches out to
the business groups for their thoughts and input about who
else needs to be in the loop. Of necessity, each staff
member has specialties, but Mills also encourages
cross-training.

Firm-wide education is a big part of
the job. Mills and her staff prepare presentations for the
groups they have identified and scale those presentations up
or down as needed. Mills finds that small group sessions,
where there can be much discussion tailored to specific
businesses, tend to work best, even though that may mean
doing a lot more sessions.

WORKING INSIDE

From her assessment of
each new rule or proposal and its impact on her employer,
Mills plans her internal and external strategies. She always
agrees on deliverables with the relevant business groups,
but depending on the size and the scope of the project, may
or may not formalize this in writing. Generally her group
prepares the final memo regarding implementation, with input
from the business unit.

Just explaining the
requirements can be fairly involved. Initially, Mills’ group
provides a high-level explanation, with basic concepts and
areas that will be affected. Then as the CPAs and business
units drill down to the next level, additional questions
arise. Where specific answers are not spelled out in the
standard itself, Mills and her group will then interpret the
standard. (see “Translating
the Standards,” JofA, June99, page 29 .)

The recent implementation of Statement no. 133,
Accounting for Derivative Instruments and Hedging
Activities, illustrates how this works. This standard
had the most impact on the treasury group, which issues all
of Merrill’s debt. Mills met weekly with the treasury
department and its accounting support to develop a project
plan and then discuss the relevant issues. As it happened,
this group was implementing new computer systems at the
time, so Mills was able to integrate the new standard’s
requirements into the unit’s technology plans as follows:
the system used to track the company’s debt needed to track
the identification numbers for a swap hedging the debt so
the debt system could interface with the swap valuation
system automatically and generate the accounting entries
required under Statement no. 133. (For more on this topic,
see “Practical
Issues in Implementing FASB 133,” JofA, Mar.01,
page 26. )

For a global business, implementing
U.S. standards may involve the foreign offices, but the
nature of the interaction is the same as with units back
home. “The challenge for us is to understand the different
type of issuance or a different concentration of the
business,” she says, “and then explain which aspects of
accounting standards will have an impact.”

In Tokyo,
the company tends to do more debt issuances with complex
interest rate features, as part of a structured note
program, and those are subject to special rules in Statement
no. 133. So Mills needed to focus more on this area for the
Tokyo office.

EXTERNAL OUTREACH

The external part of
Mills’ job—maintaining a liaison with the standards
setters—is the other half of her role. She wants to make
sure those who issue the standards understand the real-world
business and industry context in which they will be
implemented. “Since they are not dealing with these products
and services on a day-to-day basis, it can be helpful for
the regulators to hear how they work,” Mills says.

Educating the standard setters may be as straightforward
as translating industry jargon into generic accounting
terms. The securities industry abounds with product acronyms
and highly specialized transactions. A repo, or repurchase
agreement, for example, is one in which a firm lends a
security to another and receives cash while simultaneously
agreeing to repurchase the security at a future date. It is
recorded as a liability on the balance sheet. Resales are
the exact opposite transaction and are also referred to as
“reverse repurchase agreements.” It is easy for newcomers to
get confused as to which side of the transaction, and which
side of the balance sheet, is under discussion.
Occasionally, other sectors of the financial services
industry use the same words with different meanings, adding
to the confusion.

During a proposal’s comment period
Mills routinely pulls together and writes the corporation’s
formal response. Coming to a firm-wide opinion to be
delivered on Merrill Lynch letterhead can be a challenge for
her. Before she can respond, she solicits the input of her
constitutents, such as the specialists in risk management,
treasury, tax, the legal department and operations. Internal
audit is always in the loop. Most accounting changes will
affect computer systems sooner or later, so systems
personnel have a seat at the table.

After she drafts
a response, everyone she or her staff has met with gets a
chance to review it and clarify any issues. Mills finds it
best to get input and approval from senior management early
to avoid last-minute changes. For example, there was a
proposal issued this year by the joint working group of
standard setters on fair value accounting that was about 300
pages long, not something senior executives have the time to
read and digest. So Mills’ first step was to identify what
the key issues were and discuss with senior management what
Merrill Lynch’s planned response would be.

INDUSTRY LIAISON

“The financial services
industry is enormously complex and has received a lot of
attention from the standard setters in the past few years,”
Mills says. Participation in industry associations enhances
Mills’ ability to offer Merrill Lynch’s cooperation and to
be pro-active with the standard setters. She chairs the
accounting policy committee of the Bond Marketing
Association and serves on the dealer accounting committee of
the Securities Industry Association (SIA) and on two AICPA
groups: the blockage factor and the stockbrokerage and
investment banking regulatory liaison task forces. This
participation gives Mills—and her counterparts at other
companies—the opportunity not only to share information and
concerns but also to unite in an industry presentation to
the regulators when appropriate. This joint effort can
inform the standard setters that issues are not unique to
one company or just the largest ones but important to
financial institutions overall. (see “Same Concerns at
Smaller Institutions,” at the end of this article.)

Take, for instance, FASB Statement no. 140,
Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities. The
original FASB proposal called for showing the gross notional
value of collateral that is in the possession or control of
secured parties on the balance sheets of those secured
parties. The Bond Market Association’s accounting policy
committee suggested, instead, measuring the value of the
right to use collateral. Although FASB had considered this
alternative, it had not proposed the idea for reasons of
practicability. The six firms on the committee offered to
test their counter-proposal because they believed it had
merit. Mills and the committee members spent the next few
months asking their own accounting and business personnel
how to implement the proposal. They also pulled data for a
sample period to determine the impact on the firms’
financial statements. The six firms then made a presentation
to FASB that reported implementation was possible, but the
numbers obtained were so immaterial, it didn’t seem worth
doing.

Ultimately, Statement no.140 contained
neither what FASB had originally proposed nor the Bond
Market Association’s counter-proposal. Rather, secured
parties must include the notional, or contract, value of
collateral that is available for their use, but only in the
notes to their financial statements.

STAY AHEAD OF THE CURVE

Mills also lays
groundwork within her company for whatever may be coming
from the regulators. “Let’s figure it out now,” she advises
the various affected business units, “since we might need to
do this for real in six or nine months.”

The long
gestation period of FASB Statement no. 141, Accounting
for Business Combinations, and Statement no. 142,
Accounting for Goodwill and Intangible Assets,
provided an opportunity for Mills to leverage the
internal and external aspects of her job.

FASB
considered accounting for business combinations and the
treatment of goodwill and other intangibles, starting in
1996, and issued its ED in September 1999. In the following
year, while at Goldman Sachs, Mills made her first
presentation to FASB on the subject and later continued that
dialogue on behalf of Merrill Lynch. FASB’s proposal, which
eventually resulted in the new standard’s eliminating
pooling and goodwill amortization in Statement nos. 141 and
142, sounded good to many, including Merrill. (for more on
this subject, see “Say
Good-Bye to Pooling and Goodwill Amortization” JofA,
Sept.01, page 31. )

While Mills conducted
the external dialogue, she also met with the Merrill Lynch
strategic planning personnel who research and recommend
business combinations for the company itself. “How would we
implement this together?” she asked. “What kinds of things
would you be looking at and measuring and how?”

During the proposal’s comment period, a team of FASB
staff and board members conducted confidential field visits
with corporate America. Accompanied by the company
controller, Mills participated in those visits, which were
aimed at uncovering the same kind of information she was
collecting internally. FASB had genuine concerns about
practicability for its constituents and arrived at each
meeting with a long list of questions about how the standard
would be implemented, which reporting units would be
affected and what exactly was currently on a company’s
balance sheet.

The next major project Mills is
gearing-up for is one that will have an impact on a number
of accounting rules: fair value, the requirement to value
all financial instruments on a market value basis. For
companies other than those already using this accounting
methodology, FASB’s project will “dramatically change the
historical cost model of accounting,” says John Fosina, CPA,
first vice-president and legal and regulatory controller and
Mills’ boss. Given that financial instruments are the stock
in trade for financial institutions, they use fair value
accounting on their balance sheets and have much to
contribute to the project’s outcome. Still, there are
“pockets” where Merrill Lynch does not use fair value
accounting, or “mark-to-market.” For example, structured
liabilities are notes issued by Merrill Lynch on behalf of a
client, which will incorporate whatever risk exposure the
client desires. Though these notes are issued in the form of
Merrill debt, their primary purpose is not to raise money
for the company but to tailor a product to a client’s
specific needs. Because of the intricacies of the accounting
for these notes, Merrill is not always permitted to mark
these instruments to market in their entirety. The SIA
committee Mills serves on believes that in these situations
it would be more appropriate to record the entire instrument
at fair value and has made that recommendation.

WORKING INSIDE : THE
CLASSICS

Implementing accounting policy
is more than reacting to new rules or trying to influence
rule making. The ongoing businesses of Merrill Lynch would
require accounting guidance even if the rule makers shut
down.

Merrill has a standing new product review
committee on which Mills serves with the same specialists
she may contact when she is investigating new standards. A
new product or “structured transaction” (a trade that has
been tailored for a particular customer and may not be
exactly like any other) gets examined from all relevant
perspectives early in the process. Traders and investment
bankers are routinely tailoring transactions for corporate
and institutional customers. Such structured transactions
involve cash assets (stocks and bonds) plus related
derivative instruments. The players in a structured
transaction are Merrill Lynch, the client and, often, trusts
and special- purpose corporations.

A common
structured transaction is a securitization of an asset such
as credit card receivables. The client will securitize the
assets using a special-purpose trust and retain a residual
interest in the trust. If the transaction is not designed
appropriately, however, the trust or assets could wind up
having to be recorded on the financial institution’s balance
sheet. This is an undesirable outcome for a number of
reasons, not least because the transaction would then
require the financial institution to put up capital against
it. But if the transaction is designed properly from an
accounting perspective, all of this can be avoided. That’s
where Mills and her team come in.

Mills encourages
businesspeople who, after all, are very concerned with the
accounting and tax needs of their clients, to approach her
on an ad hoc basis. The rules can be hard to summarize,
especially for those who have not followed the development
of the standards and may not have any accounting background.
In putting together a highly complex and customized
transaction, a trader may be focused on the client. But
Mills has to be sure a product has no unintended
consequences on Merrill Lynch’s financial statements.

JOB SATISFACTION

Mills’ major challenge
is making sure that she is on top of how the accounting
standards are working and that she has reached out to
everyone she needs to. Her reward is job satisfaction.
Constant innovation in a dynamic industry is something Mills
loves about her job. She mentions how the traders and other
businesspeople she works with come up with something new, it
seems, every day. “You get to see products on the ground
floor. You are challenged on a daily basis, not just to be
on top of accounting principles but to put them into
practice.”

Often a new standard helps an accounting
policy director to protect the corporation. Are there too
many standards? “People complain about increasingly complex
standards. But we have increasingly complex products,” Mills
says. Multiple agencies run the risk of contradicting each
other, at least occasionally and at least during the comment
period. “It is one of the things we watch out for,” Mills
admits. And things could change tomorrow. “I think it’s
harder if you are not following the literature as it
develops,” she says.

Mills encourages those with the
necessary resources to participate and make their concerns
known. Indeed, CPA interaction with the standard setters can
be an opportunity to have an impact on a standard’s outcome.

N ot everyone
responsible for implementing accounting policy and
standards at a financial services institution has
the resources of a very large global corporation
with a department dedicated solely to that purpose.
A more typical experience for corporate CPAs and
financial executives occurs at PFF Bancorp, Inc.
located in Pomona, California.

Publicly traded
PFF Bancorp owns 100% of PFF Bank & Trust, a
national savings bank with nearly $3 billion in
assets and 24 retail banking branches in Southern
California. The bank, a successor to a savings and
loan association that first opened its doors in
1892, is in transition from a traditional thrift
to a community bank. Gregory C. Talbott, CPA and
CFO, operates an accounting and finance division
with 20 people, including the controller and the
vice-president of finance.

Talbott is
responsible for implementing accounting standards
at PFF. “As the principal accounting officer, it’s
my signature on the 10-Q and the 10-K,” he notes.
So he, just like Esther Mills at Merrill Lynch,
must review all pronouncements and standards in
order to get his arms around them, even though
they will not all be equally relevant to the
smaller PFF.

For example, he spent
considerable personal energy, over some years,
assessing the evolving nature of FASB Statement
no.133, Accounting for Derivative Instruments
and Hedging Activities, as well as his own
expertise with hedging. “Nobody understood quite
what it was when it first came out. I didn’t know
whether the standard would have much application
to us until the last chapter was written,” Talbott
notes. He read FASB’s output and commentary, and
attended meetings and seminars to keep up.
Ultimately, though, the impact on PFF was limited.

But Statement no. 115, Accounting for
Investment Securities, was something PFF
needed to understand, and Talbott was responsible
for seeing that it did. The first step, assessing
whether and to what extent the standard was
relevant to PFF, was fairly simple for its CFO
because the bank had nearly 30% of its assets in
marketable investment securities—a sizeable stake
for the institution.

While staying on top
of new rules and proposals may look pretty similar
for financial institutions of all sizes,
implementation can look quite different. For
Talbott, implementation of change can mean
up-close and personal. For example, since
Statement no. 115 required the bank to make a
distinction between securities that were available
for sale and those held to maturity, Talbott
personally sat down with his controller and
assistant controller to identify and categorize
all of the bank’s security positions. Similarly,
he was directly involved in addressing how to make
the new policy operational—setting up the systems
needed to capture market value on a monthly basis
and creating a new general ledger account for
unrealized gains and losses.

PFF relies on
its independent auditor, KPMG, with respect to the
internal implementation of accounting standards.
“We ask the auditors to review what we have done
to ensure that we have implemented properly,” says
Talbott. This may include running policies past
the auditors when they are specifically written to
implement a new standard. But, mainly, KPMG alerts
Talbott to any shortcomings through its quarterly
review of financial statements and the auditors’
understanding of the underlying business and its
accounting.

Talbott spends about 10% of
his time serving on industry and professional task
forces and committees. He participates on the
Financial Institutions Accounting Committee
(FIAC), a group of 16 thrift industry senior
executives, sponsored by the Financial Managers
Society, a Chicago-based trade association of
thrifts and commercial banks. Though this is a far
smaller proportion of PFF’s time than a much
larger company can invest, Talbott is enthusiastic
about the leverage he gets from participating with
these groups.

First, the primary role of
FIAC is to communicate with the regulators and
accounting standards setters regarding issues of
concern to the industry. To that end, FIAC meets
annually with FASB and, several times a year, with
the SEC and other federal regulators. For Talbott,
FIAC’s meetings serve as his principal forum for
communicating with and responding to regulators
and accounting standards setters. This is “very
much a two-way street” he says. “They want to know
what’s on our minds and we want to get their
views.”

Second, according to Talbott,
there is a similar reciprocity and leverage within
FIAC. Without a large staff of accounting experts
at his disposal daily, Talbott finds listening to
the input of his peers on FIAC to be invaluable.
He further finds that participation in FIAC
prompts him to keep current so he can be a valued
contributor himself. “It’s a kind of forced
discipline,” says Talbott.

In the end, the
regulators and standards setters contribute to
accomplishing the job at PFF. But do the costs of
the rule-making machine outweigh the benefits? “We
do have a tremendous number of accounting
standards that have gotten extremely specific. But
I believe that is necessary,” says Talbott. He
responds thus to criticism of the accounting
standards setters for their steady stream of
output for two related reasons. “In all
industries—but especially the financial services
industry—things have become increasingly complex.
I don’t believe we have any alternative but to
have the number and scope of pronouncements that
we have.”

Talbott says as the creativity
and variability of business practices evolves it
is important to have consistency among companies.
“The primary role of accounting and financial
reporting is to present an accurate picture of the
true economics of the enterprise, even though the
units may be doing business in different ways and
employing different instruments and strategies.
Accounting principles are the means to that end,”
says Talbott.

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